ROELOF BOTHA AND DARYL SWANEPOEL: Global growth prospects — lower interest rates required

The latest World Bank global economic outlook, published in January, is riddled with tales of woe. Global growth is expected to amount to just 1.7% in 2023, a sharp correction of the 3% expected six months earlier.

The IMF is considerably more optimistic than its sister organisation, presumably because their forecasts are based on different analytical methodologies, which result in the World Bank giving less weight to emerging market economies. According to the IMF this group, combined with other developing economies, will account for 46% of global growth this year, with advanced economies contributing 54%. 

With the IMF predicting that global GDP will increase 2.8% in real terms (more than $5.3-trillion in nominal terms), it seems strange that talk of recession continues to surface. When the world’s three largest economies (the US, China and Japan) are expected to expand economic output by a combined value of more than $2.8-trillion, attention should rather shift towards the underlying reasons for the IMF’s belief that the world economy will continue to grow and recover from the lingering effects of the Covid-19 pandemic.

Risk perceptions can change quickly, depending on the speed and effectiveness of a combination of remedial policy interventions, heightened diplomacy and changing macroeconomic circumstances in general. A case in point is the dramatic decline in freight shipping costs, which has played a big role in the gradual return to a measure of price stability in most countries, thereby signalling an imminent end to hawkish monetary policy and higher interest rates. 

With a bit of luck the latest round of rate hikes by the US Federal Reserve (Fed) and several other big central banks will be the last, due to a combination of lower median global inflation and a growing realisation of the damage tighter monetary policy is inflicting on economic recovery in general and the plight of indebted households in particular. 

Negative side effects from the fast rise in policy rates over the past 18 months are becoming apparent. The rapid monetary policy tightening by central banks that followed higher inflation has led to banking sector vulnerabilities, though so far this has been confined to the US and Switzerland. To a large extent the recent failure of three large US banks can be attributed to the overzealous switch to a hawkish monetary policy stance by the Fed, which led to an 85% increase in the cost of capital over the past year. 

These developments have created nervousness among global fund managers, contributing to a lengthy period of risk-off sentiment induced by the steep increase in US Treasury bond yields. According to the Global Economic Outlook published by the World Bank in January, higher interest rates are exerting substantial drag on economic activity. This is set to deepen given the traditional lags between changes in monetary policy and its economic effects, which in the current scenario have worsened a cost-of-living crisis among lower-income groups, especially in emerging markets and developing economies. 

Though a recent survey among leading economists from both the public and private sectors conducted by the World Economic Forum revealed a sanguine attitude towards the systemic implications of the recent financial disruption in the US, it did point out potentially damaging knock-on effects. Businesses are expected to find it more difficult to obtain bank loans and property markets face the prospect of disruption. 

It is clear that sharp increases in interest rates have made it more difficult for governments to encourage economic growth via infrastructure investment and soften the plight of the unemployed with enhanced expenditure on welfare programmes. Fiscal leeway has narrowed in most countries, mainly due to dampened fiscal revenues (induced by lower growth) and increased welfare expenditure as a result of rising unemployment.  

When analysing the nature of the global surge in higher prices over the past two years two factors played a big role in the price instability that ensued immediately after the worst of the Covid-19 pandemic, but they have more or less run their course. 

It turned out that oil was not the big culprit, but rather the cost of shipping oil and all other traded goods from one port to another. The continued supply chain disruptions caused by Covid-19 and worsened by Russia’s invasion of Ukraine have provided a stark reminder of the strategic economic importance of maritime container trade.  

Ultimately, too few ships and an explosive recovery of demand conspired to send freight costs into orbit, with the Statista Freight Rate index increasing from $1,262 per container during the third quarter of 2019 to $10,361 in the same quarter of 2021 — an unheard-of increase of more than 700%. Fortunately, these costs have almost normalised, with the Statista index having declined 83% from the 2021 peak to below $2,000. 

A second reason was the extraordinary spike in energy prices, especially natural gas. Pandemics and wars are not conducive to energy market stability, as witnessed between April 2021 and August 2022. In 17 months the price of Australian coal increased fourfold and the price of European natural gas almost tenfold. Over this period the increase in the Brent crude oil price was more muted, but nevertheless more than 50%.  

Fortunately, energy prices have entered a marked downward pattern since the third quarter of 2022, with Brent crude, coal and natural gas having declined 25%, 52% and 81% respectively.  

In the case of several emerging markets, currency weakness played a part in raising the prices of imported goods. This was not necessarily related to any policy weakness, but rather to the relentless rise in the value of the dollar during the first three quarters of 2022. The greenback may be running out of steam, though, which bodes well for a recovery of emerging market currencies. 

Despite the Fed having increased its official bank rate to a range of 5%-5.25% in May, the yield on 10-year US bonds has started to move in the opposite direction, declining almost 70 basis points between the beginning of March and mid-May, and by more than 80 basis points since October 2022, raising prospects of an imminent shift towards a risk-on sentiment among fund managers. 

Recent IMF analysis suggests that once the current inflationary episode has passed, interest rates are likely to revert towards prepandemic levels in advanced economies, with emerging markets following suit. This was based on annual data on fiscal and macroeconomic aggregates for a sample of 33 emerging market economies starting in 1990, and 21 advanced economies starting in 1980, and included the effect of monetary policy on public debt sustainability.  

An interesting conclusion is that economic growth and inflation have historically contributed to reducing debt ratios. Reading between the lines, it seems a larger degree of policy tolerance and patience towards higher inflation may produce macroeconomic benefits in the form of higher growth and concomitant fiscal leeway. 

• Dr Botha is an independent research economist, and Swanepoel CEO of the Inclusive Society Institute. This article draws on the content of an institute paper, ‘End warfare and rather save the planet’.